Navigating Bitcoin Forks: Covenants and the Future of Protocol Upgrades

Briefing Notes

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Summary

The May 19, 2022 episode of the What Bitcoin Did, featuring Adam Back and hosted by Peter McCormack, explores the complexities of Bitcoin protocol upgrades through Bitcoin Improvement Proposals (BIPs), focusing on the contentious Covariance Transaction Verification (CTV) proposal. The discussion highlights the risks and opportunities presented by covenants in Bitcoin’s transaction framework and the challenges of reaching consensus in a decentralized governance model. The episode emphasizes the importance of peer review, security, and the long-term evolution of Bitcoin, while also addressing concerns over fungibility and regulatory influence.

Take-Home Messages

1. Consensus is critical for Bitcoin upgrades. Any proposed changes, such as covenants, must undergo thorough peer review to maintain Bitcoin's security.
2. Covenants offer programmability but raise fungibility concerns. They may introduce advanced transaction features but could also lead to restricted transactions, affecting Bitcoin’s open nature.
3. Speedy Trial activation for upgrades is risky. Using this method can bypass proper review and lead to hasty decisions that undermine Bitcoin’s decentralization.
4. The slow evolution of Bitcoin is a strength. Deliberate, cautious changes help protect the network from instability, ensuring it remains resilient to both technical and external threats.
5. Bitcoin governance relies on trust and transparency. Non-technical users must trust developers, but developers must collaborate openly to maintain confidence in the upgrade process.

Overview

Peter McCormack hosts Adam Back in this episode to explore why Bitcoin forks and protocol upgrades, such as covenants and CTV, are often contentious. Back explains the origins and role of Bitcoin Improvement Proposals (BIPs), highlighting their importance in maintaining Bitcoin’s decentralized governance. BIPs serve as a formal process for proposing changes to the Bitcoin network, yet achieving consensus remains a significant hurdle.

The conversation focuses heavily on Jeremy Rubin’s CTV proposal, which introduces covenants—a new programmability feature in Bitcoin’s scripting language. Covenants could enable advanced transactions, such as time-lock vaults, but also raise concerns about Bitcoin’s fungibility and privacy. Adam Back elaborates on how Bitcoin’s cautious approach to upgrades helps prevent unforeseen risks, while McCormack underscores the importance of trust in the developer community for non-technical users.

Adam Back also discusses Bitcoin’s governance process, likening it to internet protocol governance, where consensus is reached through careful peer review. He reflects on past upgrades, such as Taproot and SegWit, as examples of how Bitcoin has successfully navigated contentious changes. The conversation emphasizes that Bitcoin’s slow, cautious development is key to preserving the network’s security and avoiding pitfalls seen in other networks like Ethereum.

The discussion concludes by acknowledging the importance of developer collaboration and transparency in ensuring that Bitcoin’s upgrades reflect the broader community’s interests. Back stresses that covenants must undergo rigorous testing and consensus-building before any activation is considered.

Stakeholder Perspectives

• Developers are concerned about the technical implications of covenants, especially how they could affect Bitcoin's fungibility and decentralization. They prioritize thorough peer review and community consensus for any significant changes to the protocol.
• Institutional Investors view covenants as a way to enhance long-term security for large holdings, making Bitcoin more attractive. However, they worry about the potential for regulatory influence, which could introduce transaction restrictions and undermine Bitcoin’s permissionless nature.
• Regulators may see covenants as a tool to enforce financial regulations, such as anti-money laundering (AML) policies, by enabling more controlled transactions. This could lead to pressure on developers to adopt features that favor institutional interests, potentially compromising Bitcoin’s decentralization.
• Retail Investors are primarily focused on preserving Bitcoin’s fungibility and privacy. They fear that covenants could impose restrictions on how coins are spent, eroding trust in Bitcoin’s role as a neutral financial system.

Implications

The introduction of covenants through the CTV proposal could significantly impact Bitcoin’s functionality and adoption. Covenants have the potential to enhance Bitcoin’s security by enabling programmable transactions, such as time-lock vaults, which would appeal to institutional investors and long-term holders. However, covenants also introduce risks related to fungibility, privacy, and the potential for regulatory or corporate control over transaction rules. If covenants allow for whitelists or blacklists, this could lead to coins being treated differently based on their transaction history, undermining Bitcoin’s core principle of fungibility.

Bitcoin’s decentralized governance model is both its strength and its challenge. The process of reaching consensus through peer review and community discussions ensures that changes are thoroughly vetted, but it also means that upgrades can take years to implement. This cautious approach helps safeguard Bitcoin against hasty decisions that could lead to vulnerabilities. The debate over CTV highlights the importance of maintaining this process, particularly in the face of external pressures from regulators or corporations.

Future Outlook

The future of Bitcoin protocol upgrades will depend on the community’s ability to balance innovation with security. Covenants represent an exciting opportunity for Bitcoin to expand its capabilities, particularly in terms of programmable transactions and scalability. However, introducing covenants without broad consensus could create significant risks, particularly if they are used to impose restrictions on how Bitcoin is spent.

As Bitcoin continues to evolve, its decentralized governance model will remain crucial to ensuring that the network remains secure and resilient. Developers must continue to focus on collaboration and transparency, while resisting external pressures that could compromise Bitcoin’s core values. The lessons learned from past upgrades, such as the Blocksize Wars and Taproot, will guide future decisions, helping Bitcoin grow while preserving its foundational principles of decentralization and security.

Information Gaps

• How would covenants impact the scalability of Bitcoin transactions, particularly in high-volume, institutional use cases? This is crucial for determining whether covenants can support Bitcoin’s growing transaction volume without compromising security. If covenants improve scalability, Bitcoin could become more attractive to institutional investors and large-scale users.
• How might covenants affect Bitcoin's fungibility, particularly regarding the risk of creating “tainted” coins that are not freely transferable? Understanding how covenants may impact fungibility is essential for preserving Bitcoin’s role as a neutral currency. If certain coins become “tainted” due to transaction restrictions, it could undermine confidence in Bitcoin’s openness.
• What are the risks of using Speedy Trial activation for significant Bitcoin upgrades, and how could these risks manifest in practice? Speedy Trial activation poses risks by potentially bypassing thorough peer review. This question aims to uncover the long-term implications of fast-tracking upgrades, particularly on network stability and security.
• How might covenants open Bitcoin to external pressure from governments or corporations, and what safeguards can be put in place to preserve Bitcoin’s decentralization? Covenants may introduce new avenues for regulatory control, which could threaten Bitcoin’s permissionless nature. This question is crucial for understanding how Bitcoin can evolve without succumbing to external influences.
• In what ways could covenants contribute to Bitcoin's scalability, especially in terms of UTXO sharing and reduced transaction sizes? Exploring how covenants can improve transaction efficiency is important for addressing Bitcoin’s long-standing scalability challenges. Understanding their potential role in optimizing transaction processing could unlock new use cases.

Broader Implications

Impact on Bitcoin Governance

Bitcoin's governance, which emphasizes slow, consensus-driven upgrades, could be tested by future proposals that introduce more significant changes to the protocol. As Bitcoin continues to grow and attract institutional interest, there may be increasing pressure to streamline the upgrade process. However, doing so risks undermining the very decentralization that makes Bitcoin resilient. Ensuring that Bitcoin remains difficult to change, even under external pressure from regulators or corporations, is crucial to preserving its core ethos.

Institutional Adoption and Regulation

As covenants introduce programmability into Bitcoin transactions, institutional investors may be more inclined to adopt Bitcoin for long-term holdings and security features like time-lock vaults. However, this programmability could also attract increased regulatory scrutiny. Governments and financial institutions may seek to leverage covenants for compliance with anti-money laundering (AML) and know-your-customer (KYC) policies, introducing potential risks to Bitcoin’s permissionless nature. If covenants become widely used for regulatory purposes, it could set a precedent for further controls over Bitcoin transactions, leading to a more compliant—but less decentralized—system.

Technological Innovation and Scalability

The broader impact of covenants on Bitcoin’s technological innovation extends beyond programmability. Covenants could serve as a stepping stone to more advanced smart contract capabilities, enabling Bitcoin to compete with other platforms like Ethereum in certain use cases. This would likely lead to increased demand for Layer 2 solutions, such as the Lightning Network, to handle growing transaction volumes. In the long term, Bitcoin's ability to integrate more complex programmable features without compromising security will be a key factor in its ability to scale and support new financial applications.

Privacy and Fungibility Risks

The introduction of covenants also raises concerns about Bitcoin’s privacy and fungibility. Broader use of transaction restrictions could create “tainted” coins, reducing Bitcoin’s fungibility and potentially creating a two-tiered system of "clean" and "restricted" Bitcoins. This could erode trust in Bitcoin as a neutral and private store of value. In a broader sense, this issue could trigger new privacy-focused developments within the Bitcoin community, driving innovation in privacy-preserving technologies such as CoinJoin or confidential transactions. If the community fails to address these concerns, Bitcoin’s global appeal as a decentralized, permissionless currency could diminish.

Global Financial System Integration

The debate over covenants also touches on Bitcoin’s integration into the global financial system. Covenants could make Bitcoin more attractive to large institutions and nation-states seeking to use programmable, secure transactions for sovereign or institutional purposes. However, this integration comes with risks. If Bitcoin becomes more deeply enmeshed in the traditional financial system, it may face regulatory constraints and centralized control mechanisms that could dilute its decentralized nature. The broader challenge will be to balance Bitcoin’s open, permissionless system with the demands of a regulated, global financial ecosystem.